Bankruptcy Blues

Chapter 11 doesn’t have to be the final chapter in a retailer’s story. For some, it could be the prologue to a new and improved future.

Seth Lehr, a partner at Philadelphia-based LLR Partners, explained, “When done correctly, filing for bankruptcy can be a powerful way to reposition a company. For instance, if there are underperforming stores in the portfolio, Chapter 11 allows you to get out of the leases.”

Granted, new bankruptcy laws leave companies with less time to restructure the business, liquidate underperforming assets or negotiate with landlords. Witness the recent demise of Sharper Image, which announced last month that all of its stores would close after attempts to restructure or sell the business failed. Sharper Image filed for bankruptcy in February and announced the business was for sale in April.

With profits plummeting, and lines of credit disappearing, many retailers feel vulnerable and are taking preemptive actions to mitigate long-term repercussions.

For instance, Dillard’s announced it will close underperforming stores this year and reduce expenses. The company’s profit fell 94% in its fiscal first quarter that ended on May 3, with net income of $2.7 million vs. $42.9 million for the same period in 2007. Same-store sales were down 6% in the first quarter on total revenues of $1.71 billion compared to $1.8 billion the previous year. The month of May was no better for Dillard’s, with same-store sales 7% below 2007.

Similarly, Talbots, Inc., announced early this year it would close 20 underperforming stores—and that was before it received the surprising news in April that Bank of America as well as The Hong Kong and Shanghai Bank of Tokyo had canceled the retailer’s lines of credit. Last month, Talbots took another precautionary step, announcing it would cut staff at its corporate headquarters in Hingham, Mass., by 9%, including the elimination of its COO position held by Philip Kowalczyk. The reduction in staff is expected to save Talbots $14 million this year.

As grim as these actions are, in times of financial crisis these are the steps that separate the survivors from the Sharper Images of the industry.

Mary Ann Domuracki, managing director of the Restructuring and Special Situations practice at New York City-based Financo, advised retailers, “Watch the nuts and bolts of the business. Stay focused on inventory management and the basics of expense control.

“This is not a market to be aggressive in and it is not business as usual,” she continued. “It takes more time to renew a line of credit. Banks are asking for more covenants, added liquidity and more capital in the companies, and lenders are skittish and more cautious.”

Private-equity firms still have money to invest, but as Lehr noted about LLR Partners, “We don’t have an enormous appetite for retail investment—it would have to be an unusual situation with nice solid comps for some time. It’s unlikely that you would find investors willing to go into retail for the first time unless the retailer has an unusually asset-rich operation.”

While financing is available for the select few, money is not cheap. “Hedge funds are filling the void where banks used to lend, but it’s more expensive money,” said Domuracki. “Opportunistic buyers will always exist, and we’re going to see more money raised for distressed investing.”